Cyclical unemployment rises when demand and output fall

Cyclical unemployment is joblessness tied to the business cycle. It tends to rise in recessions, when weaker economic activity reduces employers’ demand for labour, and to fall during expansions as demand and hiring recover.

When households and businesses spend less, firms may sell less and cut production. They may then freeze hiring, leave vacancies unfilled or lay off workers. That sequence, from weaker demand to lower labour demand, is the central mechanism behind cyclical unemployment.

How the business cycle affects jobs

Firms hire workers to produce goods and services. In a slowdown, a fall in expected sales can lead them to seek fewer workers at any given wage. In an expansion, stronger expected sales can increase the quantity of labour firms seek.

1. Demand for goods and services weakens.
2. Firms reduce production or postpone recruitment.
3. Vacancies and hiring decline, and some firms make layoffs.
4. Unemployment rises as fewer jobs are available.

Layoffs may be more common than broad wage cuts when wages are slow or difficult to reduce. Lumen Learning identifies contracts, legal wage floors, employer-worker expectations and retention considerations among factors that can contribute to downward wage stickiness.

Construction during the 2008 crisis

The 2008 financial crisis provides an illustration. Investopedia says the collapse of the housing bubble, borrower defaults and tighter lending standards reduced demand for new construction. It attributes approximately 1.5 million unemployed construction workers to the episode; Coursera reports construction employment fell by 1.5 million jobs between 2007 and 2009.

The example shows how a contraction in demand within a major sector can reduce employment. More than one type of unemployment can exist at the same time, however, so joblessness in a sector cannot automatically be treated as solely cyclical.

How it differs from other unemployment

• Cyclical unemployment is associated with weaker economic activity and labour demand during a contraction.
• Structural unemployment reflects a mismatch between workers’ skills or location and available jobs. It can persist even when the economy is strong.
• Frictional unemployment is temporary joblessness while people enter the labour force, move between jobs or search for work.

These categories may overlap. The St. Louis Fed defines the natural rate of unemployment as the combination of frictional and structural unemployment, while describing cyclical unemployment as job losses associated with recession.

What unemployment figures can miss

In the United States, the official unemployment rate counts people without a job who have looked for work in the preceding four weeks. It is calculated by dividing the number of unemployed people by the labour force.

People who are not working and have stopped looking for work are outside the labour force and are not counted as unemployed under that measure. The St. Louis Fed identifies discouraged workers as people who stop searching because they believe jobs are unavailable, a response it says is likely during recessions. Its U-6 measure also includes marginally attached workers and people working part-time for economic reasons.

Why the distinction can be difficult

Economists examine unemployment alongside job vacancies. In weak economic conditions, unemployment is generally higher and vacancies lower. The Beveridge curve plots the relationship between unemployment and vacancies.

MIT economist Peter Diamond notes that movements along the curve are commonly treated as cyclical and shifts in the curve as structural. His analysis also cautions that separating the two precisely is difficult. A high unemployment rate alone does not determine how much joblessness is cyclical or structural.

Frequently asked questions

How is cyclical unemployment different from structural unemployment?

Cyclical unemployment is associated with weak economy-wide activity and lower labour demand during a downturn. Structural unemployment reflects a mismatch between workers’ skills or location and available jobs, and can persist in a strong economy.

Why can the official U.S. unemployment rate miss weakness in a recession?

The official U.S. measure counts people without jobs only when they have looked for work in the preceding four weeks. People who stop searching, including discouraged workers, are outside the labour force and are not counted as unemployed in that measure.

What does the Beveridge curve show about cyclical unemployment?

The Beveridge curve plots unemployment against job vacancies. Higher unemployment alongside lower vacancies is commonly treated as evidence of cyclical weakness, while shifts in the relationship may point to structural factors. MIT research cautions that this distinction is difficult to make precisely.

Sources

• Cyclical Unemployment: Causes, Types & Economic Impact — www.investopedia.com
• Cyclical Unemployment: How to Stay Relevant During an Economic ... — www.coursera.org
• Cyclical Unemployment | Macroeconomics — courses.lumenlearning.com
• Cyclical unemployment | Topics | Economics — www.tutor2u.net
• Making Sense Of Unemployment Data — www.stlouisfed.org
• Cyclical Unemployment, Structural Unemployment — economics.mit.edu